financial risk / William_Potter

Surging inflation and rising interest rates represent a mixed bag to the big banks and insurers, suggests DBRS Morningstar in a pair of reports.

With persistently high inflation pushing central banks to raise rates sooner than previously expected, the rating agency is examining the possible impact on financial institutions.

“Rising inflation can negatively affect Canadian insurers through higher operational and claims expenses,” DBRS said.

However, it indicated that these rising costs can typically be passed along to customers, as the sorts of insurance products that are most affected by inflation — such as P&C and group health policies — can raise their prices relatively quickly too.

“Overall, DBRS Morningstar expects that most of the increase in P&C claims related to inflation will be passed on to policyholders over time, limiting the risk for insurers,” said Patrick Douville, vice-president, insurance at DBRS, in a release.

As robust inflation drives interest rates higher, the effects can be mixed for both banks and insurers, the reports suggested.

Higher rates are “typically positive” for insurers over time, DBRS noted.

Yet the initial impact of higher rates can have negative impacts on earnings and capital, it said.

And “above a certain level, higher interest rates may do more harm than good for insurers if they lead to an economic downturn with increased defaults and declining asset valuations,” it noted.

“The best scenario for Canadian insurers’ credit profile is one of controlled inflation and measured interest rate increases, as both deflationary and runaway inflation scenarios pose additional risk to the industry,” the report said.

In a separate report, DBRS said that rising interest rates are also generally a good thing for banks.

“Rising interest rates are a positive for banks, as their balance sheets are asset-sensitive (assets will reprice higher faster than liabilities). Thus, net interest margins should expand, bolstering profitability,” the report said.

However, it noted that, as rates rise, so do debt servicing costs, which could lead to more household financial stress. New borrowing also becomes more costly, it added.